According to legend, the master of the Order of Assassins uttered the famous phrase “nothing is true, everything is permitted” on his deathbed prior to his soul departing for Hell.  This axiom has made its way into a number of historical accounts regarding Sabbah and the Nizari Isma'ilis. As with so much of the lore surrounding the “order”, it is likely that this quote is no more true than most of the other legends circulated by Western historians, medievalists, anarchists and occultists. It is worth looking into three competing explanations for how it found acceptance and examine the probabilities of each.
First we should examine some of the most egregious myths that have propagated through the centuries. The most obvious is that the Isma'ilis never referred to themselves as “assassins”; other groups used the terms as epithets toward the Nizaris and the efforts of many scholars to accurately identify the term's etymology have met with little success.  The most common explanation one finds — that it was a derivation of hashishin, or cannabis-users — is fairly ridiculous given the abstemious nature of Sabbah's lifestyle; indeed, he had his own son Muhammad executed for being drunk in public.  A cursory reading of poems written by Sabbah, published by the Institute for Isma'ili Studies,  indicates a man who fits more into what we might term a “fundamentalist” mindset today than a wild-eyed radical mystic. Sabbah has been referred to as the “Old Man of the Mountain” which is a compound error; the term shaykh (‘old man’ or ‘elder’) was applied only to Sinan al-Rashid — the leader of the Syrian, hence Arabic, Isma'ili faction — by the Crusaders, and “old man of the mountain” was only translated into Arabic (shaykh al-jabal) after it had appeared in Old French, Latin and Italian in European works. Moreover, Sabbah was known as Sayyidna (‘master’) among his devotees at Alamut.  Finally, there has never been substantive data which indicates there was any linkage at all between the Nizaris and Adam Weishaupt's Order of Illuminati. This appears to have been a fanciful literary exploration of Idries Shah’s, who made much of the Illuminati / Assassin association writing as Arkon Daraul in A History of Secret Societies. The connection has been endlessly hyped — without any supporting documentation, historical references, or even consideration of the geopolitical realities concerning such a relationship — by Robert Anton Wilson in some of his Illuminatus! — inspired writings and Jim Marrs in Rule by Secrecy, among others.
With this dubious track record in mind, let us turn to an analysis of the phrase and its utterer.
Barry Miles' Explanation
A significant amount of the material that built up around the Assassins has come from modern Beat and alternative writers such as William Burroughs, Brion Gysin and Peter Lamborn Wilson / Hakim Bey. Gysin visited Alamut in 1972 and noted that the fabulous Gardens reputed to have flourished there could not have had the physical space necessary to justify the myths surrounding them.  Burroughs and Gysin — among notable others — lived at the Beat Hotel in Paris at various intervals in the late ’50s –early ’60s and explored a wide array of metaphysical concepts and applications, including some Middle Eastern sources. Barry Miles in Beat Hotel writes that the essence of the quote came from a book about Sabbah by Betty Bouthol ca. 1936; Burroughs apparently arrived at the exact phrase via the “cut-up”, another method of which he was particularly fond. Taking phrases from Bouthol, he cut them into separate words, reassembling them into the axiom we know today. Miles notes further:
Over the years, Bill evolved an elaborate cosmology around Hassan, which bore little relationship to historical fact. 
The Weaver Budayl
A competing explanation comes from a historical figure who lived after Sabbah and developed a following based on the corruption some of the Nizari master's teachings, resulting in a retroactive misattribution of his words and actions to Sabbah himself. Budayl, a weaver, proclaimed:. . . there is no reality to what is declared lawful or forbidden in religion. Prayers and fasting must therefore be abandoned.
Structurally this sentiment is very close to Sabbah's wording.
The Isma'ilis reacted to his ideas by capturing and executing most of Budayl's adherents in a move that mirrored later actions against the Sufat or Pure Ones. To paraphrase Captain Willard in Apocalypse Now: what do you call it when the heretics accuse the heretic? In any case, it is possible that the spirit of the quote, if not its letter, has mistakenly become associated with Sabbah as a result of Budayl.
Haram vs. Halal
A heresiography of the various divisions of the Shi'a (the minority party in Islam) categorizes the Isma'ilis according to this precept:Their third name is hurumiyya, for they say halal about many haram actions. [. . .] For example, they say, "Paradise means to escape worships and to do enjoyable things. Hell means to endure the burden of worships and to refrain from haram actions." 
It is important to examine the substance of this statement from a linguistic viewpoint. Haram means 'forbidden', which carries the same connotations as 'unclean' in Judaic tradition. Conversely, halal means permitted, allowed or clean. Compare that to this quote, taken from Radd-i Rawafid:The Ismailiyya group, says that Qur'an al-karim has a batin [invisible inner essence] as well as a zahir [outward appearance]. The zahir, when compared to the batin, is like the shell of a hazel-nut in comparison to its kernel. Whatever a person would obtain by enduring the difficulty and trouble of obeying the commandments and prohibitions, which make up the zahir, is easily attainable by adapting oneself to the batin. So, one does not have to go into trouble by worshipping. For making people believe these statements of theirs, they quote the thirteenth ayat of Hadid sura, which points out the wall between the people who are in Paradise and those who are in Hell. They say, "There is no haram (prohibition). Everything is halal (permitted). 
Virtually Sabbah's own alleged words. It is unclear whether the classification results from the writers' encounter with Budayl-influenced material or if it arose independently of that; nonetheless, the concept is demonstrably present among Muslim scholars of the period.
The quote appears as a corruption of familiar Qur'anic pre- and pro-scriptions. It is much like a Christian priest accusing a "witch" of saying the Lord's Prayer backwards whilst engaged in an orgiastic ceremony. Taken in the broad context of religious studies (especially for textually-based religions), this is a very common occurrence: stating that a given individual or party is going against some written advice or prohibition as an indictment of their heresy.
The Truth in "Nothing Is True" and the Implications for its Acceptance
Like the etymology of "Assassin", the true provenance of "nothing is true, everything is permitted" is likely lost to the vagaries of history, poor translations and the collision between competing cultural paradigms. One, none or all of the above attempts at explanation could be correct. Does it matter who said it, and does it matter at all? These two questions are interrelated.
In the final analysis, the Isma'ilis are better known for a great many contributions to Islamic and 'Alid thought — far more (and far more important) than ascription of a crypto-anarchistic statement by its founder nearly a thousand years ago. So much of what Western historians, travelers and researchers have disseminated about the “Order of Assassins” is inaccurate, biased and misunderstood that it hardly matters whether Sabbah said these words on his deathbed or not, and modern Nizaris would be unlikely to adhere to its logic in any event. Given the data shown above, though, he could have said it. One could easily envision Burroughs formulating it — with or without a cut-up — and there have been all manner of libertines, politicians, military and religions leaders who have lived by its guidance whether they formulated the sentiment in those words or not. One finds it written in magickal journals and splashed on web pages the world over, frequently without even knowing where it came from. So the answer to the first question must be negative.
The second question is more problematic. Esoteric spiritual seekers often encounter unusual practices at various points in their initiations; sometimes these rituals involve exposure to fear, disgust, sensuality, asceticism or combinations thereof. This phrase unlocks a gateway into the realm of extreme initiations, where one must truly break the chains of the Law.  But these praxes are not for everyone, nor are they meant to substitute for the development of the soul; they are specific to a person's state of being at a given time and are strong medicine that can heal an initiate at one level and destroy him at another. Thus hearing the axiom on the mouth of a disaffected teenager is either quaint or annoying depending on one's sympathies or horrifying if that youth is on an armed rampage through a school building.
The statement is a tool — and a very powerful one — and not one for everybody’s tool box. Just as spiritual practices require guidance and wisdom from one’s initiator (whether human, oneiric, chemical or experiential), so this maxim can lead to great liberation or extreme havoc. Some need first to understand the ancient dictum “discipline precedes freedom” before they will be able to dance with the last words of Hassan-i Sabbah.
 This quote has been attributed to William S. Burroughs as well as the historian Juvaini, depending on the source material — most of which is incorrectly referenced. I was not able to find any data to substantiate Juvaini. Farhad Daftary. The Assassin Legends. London: IB Tauris & Co, 1995. p. 131ff.
 Farhad Daftary. The Isma'ilis: Their History and Doctrines. New York and Oxford: Cambridge University Press, 1990. P. 367.
 Kutub Kassam (ed.). and Faquir Hunzai (trans.). Shimmering Light: An Anthology of Ismaili Poetry. New York: St. Martin's Press, 1997.
 Daftary 1995, p. 116; Daftary 1990, p. 367ff. The Persian equivalent of shaykh al jabal is pir-i kuhistan.
 Brion Gysin and Terry Wilson. Here to Go: R101 (San Francisco: RE/Search Books, 1982; London: Quartet Books, 1982). Recently re-released as Brion Gysin: Here to Go. London and New York: Creation Books, 2001.
 Barry Miles. The Beat Hotel: Ginsberg, Burroughs, and Corso in Paris, 1957-1963. New York: Grove Press, 2000. p. 204.
 Waqf Ikhlas. Translation of Radd-i-Rawafid ("Document of the Right Word").
 Sabbah's inheritor, Hassan II, did utter a phrase which has been under-appreciated in the occult community: “The Chains of the Law have been Broken.”, thus ushering in the abrogation of Shari'a and the beginning of the golden period of Isma'ili metaphysical exploration. Daftary 1990, p. 386-88; Daftary 1995, p. 40-42.